Devloping a Basic Understanding of Forex Trading

INTRODUCTION

This will be an informal educational program.

PSYCHOLOGY OF TRADING

I thought it best that we initially cover the psychology of trading. It will help those who want to get stuck into trading as soon as possible. However remember that patience is important.

Professional traders wait for the right signals and timing before they enter a trade. Over time we will talk about a whole host of things all of which will help you to develop a logical trading system, a good money management plan and the psychology (mental skills) of trading.

Trading I suppose is a bit like a tripod, if one leg is wobbly or falls off there is likely to be a calamity and it will fall over. In other words your trading rides on three components, if any one fails, you will fail. Lets talk about the psychology of trading.

Through the course I will refer to this section many times as it is just so important. I don’t know any traders who have not experienced most of the things that we are going to talk about. It is purely because we are human and operating in a foreign environment.

What happens is that new traders, that was me many years ago, don’t perceive in advance that they are operating in a new world, a place that they have never experienced before. There is this belief that trading is like any other job. Because of this they approach trading like any other endeavour through their life. The result is that they focus their energies on gaining knowledge and learning mechanical skills.

I am not suggesting that knowledge about trading is not important, just that by itself it will not bring success. This is because the world of trading is completely different to anything that they have experienced! This is brought about by the fact that the market is always on the move, a state of perpetual motion with unlimited potential for profit and loss. This can be very stressful for some as we nearly all grow up in an environment that is quite structured.

From when quite young we got up at a certain time, had certain chores to do, like clean our teeth, go to the toilet, get dressed, have breakfast, get ready for school and so on. There were limits, boundaries, schedules and routines. We like to follow rules and feel more comfortable when things remain the same, or repeat themselves.

Working in this non changing environment becomes linked to our well being and security. I hope you understand where I am heading with this, as I believe it is just so important. It is one of the reasons that there is the saying that you are ”too close to the market,” in other words you have been out of your natural environment for too long, and this is affecting your decision making, i.e. sitting in front of the computer for too long trading.

The forex market can destroy this normal sense of security by forcing you to perform in a world where you have no control. It is taking you out of your comfort zone, where the living and working environment is familiar. You have no control as to which way the price will go, you have no control as to the price of the currencies and you have no control over the timing of the price moves.

One of the things that is difficult to comprehend is that the life principles that have been instilled in us, do not apply with trading. In other words the principles of time, effort and reward which are associated with most jobs do not apply with trading. In most jobs one is on a fixed salary so regardless of effort, the reward in the form of salaries remains the same. However for a trader time and effort are irrelevant. There is no relationship between the two principles and reward. A trader can be rewarded with a huge profit in a short period of time from making just one simple decision.

It is very important that you come to grips with the psychological differences and challenges of trading. In no way am I saying don’t become a trader, it can be a wonderful life, however it is essential to understand that emotionally we are in a different place to our normal life experiences. As one gets older subconsciously we probably developed a winning formula, this has probably come about from the input of education or just trial and error. As we want to repeat success, there is a tendency to use this successful formula for most things that we do. A new trader can be doomed from the start if he doesn’t realise that he requires a completely new set of psychological resources to achieve success.

I hope you enjoyed this introductory session to psychology in trading. As we explore this subject further, remember that essentially the discussion is about each one of us. Trading is very humbling as we are all subjected to the same emotions at different times. We will at times do silly things and subject ourselves to the comment. How could I have been so stupid! We will experience elation from having made a wise decision. And hopefully there will be a contentment as the bank balance grows.

It is important to be truthful to yourself, don’t pretend that things are going OK when they are not.

I have found that good traders, as a rule, are rather humble people. I have often thought about this, perhaps its because they know that it doesn’t matter who you are the market can and will cut you down to size very quickly. It is important to be truthful to yourself, don’t pretend that things are going OK when they are not.

Let’s have a chat about fear. We are all continuously subjected to the fear of failure in every day life. The old saying of “keeping up with the Jones” to some extent incorporates this sense of fear. We feel the need to have things over and above requirements, and similar or better to others around us; just because we don’t want to be looked upon as a failure.

In the case of the trader there is intense pressure on him to perform, he ties his self-worth to trading, becomes a perfectionist, is overly concerned about what others think, cannot accept small losses or begins skipping days, even weeks of trading because he just wants to watch the market for a while. You can identify fear in yourself, when you start to close down positions too soon with a small profit or loss. When I first started to trade it was without doubt my biggest problem. In a winning trade, the fear of losing causes you to focus your attention on any information that the market is going to take away your profit, therefore you close out early.

If you log into forex market forums, you will find posts for and against the price going long or short, on most discussed currencies. In this case, if fear is the dominate emotion; there would be a tendency to focus on the negative comments.

What happens so often, once you have closed your position the price continues to go in your nominated direction; you will then agonise over the profit left on the table and wonder why you couldn’t have hung a little longer. The tragic thing that happens in a losing trade, you will focus your attention on just the opposite information. Afraid to confront the possibility of another loss, you will focus on non threatening information. If the market comes back to your entry point you will exit the trade with a sigh of relief. If the market continues to move against you, threatening information will overwhelm you to the point where you become paralyzed. Eventually your anxiety will become so intense that the only way to relieve it is by closing the trade.

What does all this mean; well clearly fear impedes our perception. It narrows the amount of information that we can process, as well as drastically limiting the choices that are available to us. It is why the majority of traders cut profits and let losses run. How can we control this human emotion that can have such an impact on our trading? The first thing is to have a clearly defined strategy, mentally practise the mechanics of the trade.

Once I have selected a high probability trade, I then develop a trading strategy. The second thing is to rehearse the attitude in your mind, trading is not about proving anything to anybody. The third thing is to give yourself permission to make mistakes. It is OK to be wrong nobody is perfect. Forth, truly accept that all good strategies can have temporary draw-down period. Note how often the price goes negative territory, in my trading before my strategy takes over. Finally you must learn to completely trust your ability to respond to whatever information the market offers you. Traders who take these proactive steps towards controlling their fears will be more apt to stick to their trading strategy, which will in turn lead to greater profits.

I hoped that this discussion has helped you to adjust your approach to trading in a positive way. Once you have a fear under control, trading can be great fun. I am sure you will agree, fear has such an influence on our lives in so many different ways. Maybe learning how to handle fear in your trading will help you in many other aspects of life. Where to next! In the next posting I will discuss greed. There are many definitions of greed. This one will do, “a desire to have more of something that cannot be satisfied”. As we all know the market has a tendency to cater for this infectious attitude.

To be a successful trader it is not that we won’t suffer from fear and greed and other emotions, it is the managing of those emotions is what counts.

I wonder if my last post on the Psychology of Trading hit a personal bell! Over the next few sections we will explore further in some detail the human emotions which confront us on a regular basis.

Having studied both sociology and psychology at university, human behavior is of real interest to me. As an aside; part of a course I did was to do with self development. To help understand ourselves and others we did what I believe was part of the RAF sensitivity training course. We were locked up in a room for a number of days with 9 others, and everything we said had to be prefixed with “I feel”, so that you took ownership of what was said. Regardless of how big, strong, confident or wealthy, it was just amazing when all the trappings were stripped away, just how similar we were; all having the same human emotions. Because of this I am confident that this section relates to us all. To be a successful trader it is not that we won’t suffer from fear and greed and other emotions, it is how well we manage those emotions, is what counts.

DISCIPLINE

How successful we are in the market place will depend largely on our emotions; our thoughts and feelings. It will depend on our attitude towards risk and reward. We might have a brilliant trading system and money management plan. However if we are frightened, arrogant or upset, there is no doubt that our account will suffer.

In simple terms our success depends on controlling our emotions. The word that best fits is having discipline. What is discipline? It is the ability to develop a trading plan and stay with it.

Discipline is the ability to give our trading strategies sufficient time to work in our favour. It is the ability to enter the market place after we have taken a loss or losses. Discipline is the ability to trade again, enter the market if there is a good opportunity, regardless of whether we have won, lost or broke even recently.

I have discussed fear in some detail; it is now time to have a look at another human emotion, greed. I look forward to doing this in the next posting.

GREED

We have been taught and conditioned from an early age, that we must work hard and be diligent over many years to achieve financial success. Largely this is true and a good ethic to teach our children. There were all the old sayings, such as “nose to the grindstone” or “head down and backside up” and probably hundreds of others. However in the world of trading the value of hard work over long hours is seriously challenged. Large profits can seemingly be made by sitting at home drinking a beverage in air-conditioned comfort.

There are many organisations who advertise these magical systems that cost the earth, guaranteeing you a life of luxury. Join up as vast fortunes are only weeks away!! We are humans and as such we can be easily influenced by others, we allow the greed factor to come forth, “that inordinate rapacious desire” to have more and more. That is a phrase that has been used many times over the centuries, in many different contexts.

I have to be careful to watch the flavour of the language that I use! All sorts of different phrases come to mind to explain this very infectious emotion. One of the things about greed is that you can succumb to it without realising it. The market caters for this destructive attitude! What happens when we are bitten by greed, is that we start to envisage unrealistic returns from our trading, we are never satisfied with the result, when we are in a winning trade we convince ourselves that the market will keep going in our favour. The same thing happened in a loosing trade, we convince ourselves that the market is going to turn around and give us the profits.

There has been a lot of research done on these various emotions; there is one thing that seems to come to the fore, that is, the need to be detached from your trading. It should be more like a game that you want to win and not associated with funds that you can’t afford to lose. What seems to happen is that the various emotions start to dictate our decision making, in other words we think about the money that we are going to make, (in the case of the greed emotion), causing us to take our eye off the task at hand!

The more detached we are the less likely the issue of “how much is enough” issues will contaminate our perception as to what the market is doing. How can we get this greed infection out of our system? Naturally the first and foremost thing is to be on the look out for greed. It would be very unwise to think that we could never be bitten. I think at is fair to say we have all been subjected to the greed infection, at sometime in our life. I will be bold enough to say the chances are that we have or will be smitten with the greed many times through our trading career.

It is not a bad idea to put a note somewhere visible to remind us of the danger. Secondly, take particular note as to whether we have altered or abandoned our trading system. Such changes are a good indication that we have been bitten by the bug. Thirdly, never think in terms of what we can buy with the profits that we are going to make, as it takes our eye off the ball. Finally, take action immediately if we identify that we have the infection, before it really starts to play havoc with our trading decisions, and potentially put pressures on other areas of our life.I enjoyed writing about this topic; although the articles written so far are short and somewhat peripheral, I suppose they are a précis of my feelings and experiences, associated with trading over the years.

In the next post I will write about revenge; this is an interesting subject and one which afflicts many traders. We must remember that once the market becomes our enemy, we cannot win.



Risk Disclosure: Forex trading can be very risky. You should therefore carefully consider whether such trading is suitable in light of your financial condition. Since the risk factor is high you should only use “risk” funds in such trading that you can afford to lose. No safe trading system has ever been devised and no one can guarantee profits and freedom from loss. The person providing the trading signals and information in relation to the trading of forex does not promise or guarantee that the trading of forex will result in a profit or loss. Results can and do vary between individuals.